TalkingEconomics: As ECB begins QE, Greece votes for austerity to end

In Europe, neither quantitative easing (QE) nor softer loan conditions for Greece (if the newly elected far-left Syriza are successful in fulfilling their promise to end austerity and ease bailout conditions) will fix the underlying problems both face. Greece and the eurozone need structural reforms, otherwise, they risk taking the same path as Japan.

3 February 2015

Azad Zangana

Senior European Economist and Strategist

ECB takes leap of faithThe European Central Bank’s (ECB) QE programme that was announced in January will benefit the eurozone economy by reducing the risk of deflation. However, the purchase quotas may be difficult to fill given two important factors: the ECB can only buy 25% of any individual bond issue and can only make purchases in proportion to the individual country’s subscription to the ECB’s capital base. These factors will limit the number of bonds available to the ECB and if the ECB were to deem the scale of purchases to be insufficient to boost growth, it would seriously struggle to expand its programme any further. Furthermore, the ECB will potentially be buying more than three times the issuance of new government bonds between March 2015 and September 2016. This can certainly push bond yields in Europe to fall further, which in turn lowers interest rates offered by banks to the real economy. This is useful but we feel that the main impact will come through from the weaker euro, which will make European exporters more competitive internationally.

The results of Greece’s elections are a setback but not necessarily a disaster.

It is important to note that QE is not a panacea for the monetary union’s ills; for this, deep structural reforms are required. Ironically, QE will reduce the incentive for governments to implement these as it introduces a distortion to bond markets and removes the discipline that comes from market pricing based on fundamentals. Without reforms, the ECB may be forced to add additional stimulus as growth falters again, which in turn reduces incentives further. Could this be the downward spiral that leads Europe down Japan’s path?

Greek backlash against austerityIn our view, the results of Greece’s elections, which saw the far-left Syriza party win the most votes and parliamentary seats, are a setback but not necessarily a disaster. Yet another leader promising hope and a rollback of austerity has been elected, but he will probably fail. President Hollande in France is just one example of such false hope.

Where now for Greece?As we see it, the situation in Greece can play out in one of a few scenarios:

Benign outcome. Syriza wins some concessions from the Troika[1] in exchange for continuing with reforms. The economy slows but avoids a recession and the impact on wider Europe is insignificant.

Syriza fails. Syriza fails in its Troika negotiations and is unable to deliver its promised fiscal changes. The coalition breaks down and the economy slows but the wider implications are insignificant.

Grexit. Syriza fails to reach a compromise with the Toika and refuses to pay interest on Troika debt. Europe halts ECB liquidity funding to Greek banks, leading to bank runs. Eventually, Greece is forced to leave the currency union. The Greek economy suffers a deep and prolonged recession, with negative spillovers in Europe.

Troika out, but no Grexit. Troika negotiations end in stalemate with no further credit provision. Greece continues to service its loans, but has to run a larger surplus. Greek banks remain supported by the ECB so Greece stays in the eurozone. The added austerity causes a recession but spillover effects are temporary and small.

Greece’s future now depends on whether Syriza can govern in a responsible way, and recognise that major structural reforms are still needed. Unfortunately, it is hard to find optimism on this front given Syriza rhetoric. Meanwhile, Greece’s membership of the EU depends not only on structural reforms, but also on Alexis Tsipras’s ability to reach an acceptable compromise with the Troika. We are almost certainly going to see a standoff in negotiations in the near-term. The risk of ‘Grexit’ is once again elevated and investors should think very carefully before investing in Greece.

Topics:

Important Information: The views and opinions contained herein are those of the author(s) on this page, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. This material is intended to be for information purposes only and is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. It is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Past performance is not a reliable indicator of future results. The value of an investment can go down as well as up and is not guaranteed. All investments involve risks including the risk of possible loss of principal. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. Some information quoted was obtained from external sources we consider to be reliable. No responsibility can be accepted for errors of fact obtained from third parties, and this data may change with market conditions. This does not exclude any duty or liability that Schroders has to its customers under any regulatory system. Regions/ sectors shown for illustrative purposes only and should not be viewed as a recommendation to buy/sell. The opinions in this material include some forecasted views. We believe we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee than any forecasts or opinions will be realised. These views and opinions may change.
To the extent that you are in North America, this content is issued by Schroder Investment Management North America Inc., an indirect wholly owned subsidiary of Schroders plc and SEC registered adviser providing asset management products and services to clients in the US and Canada. For all other users, this content is issued by Schroder Investment Management Limited, 31 Gresham Street, London, EC2V 7QA. Registered No. 1893220 England. Authorised and regulated by the Financial Conduct Authority.

Related content

The European Central Bank's injection of stimulus and the fall in energy prices continue to provide support for the eurozone, but UK growth is likely to be hurt by austerity measures following the Conservatives' win in the May general election.